March 2, 2015
Thank you for inviting me today, and I thank Roger for that kind introduction. I want to also thank the IIB for its participation in the work of the agency. I have had the opportunity to meet with the IIB previously as well as many of you individually. I value your input and look forward to continuing to work with you.
You all appreciate that the derivatives markets we oversee are very important. These markets enable businesses of all types to manage risk. And for that reason, these markets are vital to the global economy. The success of these markets depends on many factors, and a key one is having a sensible regulatory framework.
We knew that before the global financial crisis, but the crisis certainly drove that lesson home. The absence of regulation allowed the build-up of excessive risk with respect to over-the-counter swaps market. That risk intensified the crisis and the damage it caused.
Sensible regulation is needed to prevent fraud and manipulation, as well as systemic risk. Sensible regulation can help insure integrity and transparency. And sensible regulation can help make sure our markets continue to thrive and that they work for the many businesses that need them.
So I am very pleased to be here today to talk with you about how we are accomplishing those goals. I want to talk about what we’ve been doing since June, when two of the other commissioners and I took office, and some of the areas we’ll be focusing on in the months ahead.
What this agency has accomplished, not only since June but well before that, is a credit to the CFTC staff. We have an incredibly dedicated and talented team. I also thank my fellow commissioners for their efforts, particularly their willingness to work constructively together. We may not always agree, but I believe all of us are working in good faith to carry out the CFTC’s responsibilities.
Over the last eight months, we have continued the agency’s work to bring the over-the-counter swaps market out of the shadows. The percentage of transactions that are centrally cleared in the markets we oversee has gone from about 15% in December 2007 to about 75% today. More than 100 swap dealers and major swap participants are now provisionally registered. Trading of swaps on regulated exchanges is new, but volumes are trending higher. Today, under our rules, all swap transactions, whether cleared or uncleared, must be reported to registered swap data repositories, a new type of entity responsible for collecting and maintaining this vital information.
While we have made good progress, there is much work that remains.
We have been working to finish the few remaining rules required by Dodd-Frank so the new regulatory framework is complete. Among the most important is the rule on margin for uncleared swaps, which I will return to in a moment. We are also working on the rules on position limits and capital for swap dealers. In all these cases, we have received substantial public comment that we will consider carefully.
In addition to finishing the remaining rules, we are also focused on harmonizing rules with other regulators – domestic and international – as much as possible, and I will discuss this further in a moment.
Second, we have been fine tuning our rules to make sure the derivatives markets continue to work well for participants and in particular, the commercial end-users who depend on them to hedge risk. We have made a number of changes to address concerns of commercial end-users. This has included amending our rules to enable publicly-owned utilities to continue to be able to hedge their risks effectively in the energy swaps market. We have proposed revisions regarding the posting of residual interest which is related to the posting of collateral with clearing members. We have exempted commercial end-users from certain recordkeeping requirements. We have proposed clarifications as to when a contract with embedded volumetric optionality will be excluded from being treated as a swap.
In addition, the Commission staff has taken action to make sure that end-users can use the Congressional exemption given to them regarding clearing and swap trading if they enter into swaps through a treasury affiliate. CFTC staff also recently granted relief from the real-time reporting requirements for certain less liquid, long-dated swap contracts, recognizing that immediate reporting can undermine a company’s ability to hedge.
We’ve also made some changes to address concerns that some of you have voiced as we build out this new swaps framework, such as in extending relief with respect to the clearing rules for interaffiliate transactions, or the treatment of package trades on SEFs. In both these areas we wanted to avoid unnecessary disruptions in the marketplace.
We have also been looking at the rules on trading of swaps on swap execution facilities and I expect we will make some adjustments to those over the coming months.
Another issue that has been a priority for us over the last eight months is oversight of clearinghouses. Under the new framework, clearinghouses and exchanges play an even more critical role than they have. So we have also been focused on this core infrastructure to make sure clearinghouses operate safely. I want to return to this issue in a moment, because I know many of you, particularly in your capacity as clearing members of clearinghouses, care deeply about these issues.
We also remain committed to a robust surveillance and enforcement program to prevent fraud and manipulation. We have held some of the world’s largest banks accountable for attempting to manipulate key benchmarks. We have brought successful cases against those who would attempt to manipulate our markets through sophisticated spoofing strategies. And we have also stopped crooks trying to defraud seniors through precious metal scams and Ponzi schemes. In all these efforts, our goal is to make sure that the markets we oversee operate fairly for all participants regardless of their size or sophistication.
Agenda Going Forward
Let me now turn to some of the key agenda items that we will be focusing on in the months ahead.
Margin Rule for Uncleared Swaps. The first is the rule on margin for uncleared swaps. This is one of the most important issues on our agenda today. It’s important because of the role this rule plays in the overall regulatory framework. As you well know, uncleared transactions will always be an important part of the market because certain products will lack sufficient liquidity to be centrally risk managed and cleared. Margin will continue to be a significant tool to mitigate the risk of default from those transactions and, therefore, the potential risk to the financial system as a whole.
The proposed rule also reflects our focus on the concerns of commercial end-users. As you know, we reproposed a rule in September of last year. Consistent with Congressional intent, our proposal exempts commercial end-users from the margin requirements applicable to swap dealers and major swap participants. We also worked with the bank regulators so that our respective rules are as similar as possible, and their proposed rules also now exempt end-users.
Finally, the margin rule is very important from the standpoint of cross-border harmonization. In addition to harmonizing with the U.S. bank regulators, it is very important that we try to make our rules as similar as possible with the rules that Europe and Japan are looking to adopt, and so we have spent considerable time in discussions with our international counterparts. I am willing to be flexible regarding some aspects of our proposed rule in order to ensure greater consistency. For example, the threshold for when margin is required is currently lower in our proposed rule than in the proposals in Europe and Japan. I believe we should harmonize the threshold, even if it means increasing ours. I would expect us to finalize a rule by the summer, and I expect that we will incorporate a slight delay in the implementation timetable for the rule.
I also want to note that we have heard the concerns of market participants, and in particular, clearing members, with respect to the effect of the supplemental leverage ratio or “SLR” on clearing. Under the SLR and the eSLR, margin for cleared derivatives is treated as an asset of the bank and is not permitted to be counted against the derivative exposure, and many believe this is not appropriate because margin is legally segregated. While I appreciate the fact that the bank regulators want to have a leverage ratio that is not based on risk-weightings of assets, I am concerned that the rule as written could have a significant, negative effect on clearing, which is obviously a key policy goal of the Dodd-Frank Act. I have spoken with my fellow regulators on this issue and our staffs are talking to see if there is a way to address these concerns.
Addressing Cross-Border Issues. Let me say a bit more about the issue of cross-border harmonization generally. One of the greatest challenges of implementing the new regulatory framework for swaps is the simple fact that this is a global and mobile market. I know many participants would like to see us quickly harmonize the rules. But some perspective is helpful here. As you know, the laws and regulations in most areas of financial regulation differ by country. What is different about swaps is that this market became global before it was regulated. I think that leads many people simply to expect and assume that the rules will be the same. It is of course true that the G-20 nations agreed to the same basic reform principles. But there will inevitably be differences in specific rules and requirements, because the new framework can only be implemented through the actions of individual jurisdictions, each of which has its own legal traditions, regulatory philosophy, political process, and market concerns. I believe global regulators should work together to harmonize their rules and supervision to the greatest extent possible. I am personally committed to this effort. Already, we have made great progress in harmonization. But we should recognize that this is a challenge, and progress will take time.
Clearinghouse recognition is one area we have been working on. The reforms agreed to by the G-20 have made clearinghouses more important in the global financial system. Indeed, a small number of clearinghouses today are responsible for a large part of the global market, and they may clear for customers located all over the world. As a result, I believe cooperation among regulators in the oversight of clearinghouses is critical.
We continue in dialogue with the Europeans to facilitate their recognition of our clearinghouses as equivalent. We have had productive discussions and I would hope that we could reach agreement soon. For decades, the United States has had a system of dual registration – where clearinghouses outside the U.S. that cleared futures traded on U.S. exchanges registered with us. Under this system we have engaged in very successful cooperative supervision with other regulators. Indeed, the model has worked to protect customers, it worked during the crisis, and it is a model on which the swaps market has grown to be global. Five clearinghouses outside the U.S. are currently registered with the CFTC to clear either swaps or futures traded on U.S. exchanges, or both. In addition, the CFTC is now reviewing three additional registration applications from clearinghouses located outside the United States. So this is a model that we will continue and build on.
Clearinghouse Strength and Stability. There has also been an increasing amount of discussion about clearinghouse strength and stability. Many voices are contributing to a broad discussion of these issues. Some are asking about the adequacy of a clearinghouse’s resources to deal with defaults, including capital or skin in the game. There have been concerns raised about the exposure of clearing members to such defaults, and recovery plans and resolution generally. The issues of transparency of risk mitigation measures and stress testing have also been raised. This is a good and important discussion to have. Internationally, CPMI-IOSCO has led this effort, by publishing the Principles for Financial Market Infrastructures or PFMIs, as well as their standards on disclosure which were supplemented with some additional guidance last week. They have also engaged in assessments of regulatory regimes. The PFMI standards are enhanced by the fact that under the Basel rules, exposures to CCPs that meet the PFMIs get better capital treatment than exposures to CCPs that do not meet these standards
At the CFTC, we have been active on these issues for years, and we are continuing to look hard at these issues. We have core principles that clearinghouses must follow, for example, that cover everything from financial resources and treatment of funds, to settlement and default procedures. We engage in constant surveillance of risk and frequent examinations. And so I would encourage those who participate in this discussion of CCP resilience and recovery issues to look at the full picture, and the work that has already taken place.
I think it is only by thinking about how one issue – whether it is capital, or member assessments, or margin models – relates to the entire picture that we can make well-informed decisions.
We will be holding a roundtable Thursday of this week to discuss issues pertaining to auctions and recovery plans for CCPs. I encourage you to join us.
Cybersecurity. Another important concern with respect to clearinghouses is one that is quite familiar to all of you, and that is cybersecurity. It is obviously a concern for any financial institution or, for that matter, any business today. The examples from within and outside the financial sector are all too frequent and familiar: Anthem, JP Morgan, Sony, Home Depot, and Target, among others. And it is of critical concern when it comes to our financial infrastructure.
There is no question that cybersecurity must be a priority for us. The question is how can we be most effective in this area? After all, many financial institutions are spending more on cybersecurity than our entire budget, and have more staff people working on these issues than our entire staff.
So we are addressing it in the following ways: first, cyber concerns are now part of the core principles that trading platforms and clearinghouses must meet. Second, we have required these entities to develop and maintain risk management programs and recovery procedures that meet certain standards. Third, we are focusing on these issues in our examinations. We are looking at whether the institution is following best practices. Is the board of directors focused on the issue? Is there a culture in which cybersecurity is given priority? Has the entity not only adopted good policies on cybersecurity, but are those policies being observed and enforced?
Another issue we will focus on is whether the private companies that run the core infrastructure under our jurisdiction – the major exchanges and clearinghouses for example – are doing adequate testing themselves of their cyber protections. We intend to hold a roundtable on this issue later in March.
Benchmarks. Another topic we have been focused on that I know is of interest to many of you is financial benchmarks. As you know, in the derivatives markets, thousands of contracts reference these benchmarks and indices, such as LIBOR, S&P 500, and Brent Crude. The integrity of benchmarks and indices is vital to our financial system. That is why we have focused on this issue in our enforcement efforts, as evidenced by our orders against banks that have tried to manipulate interest rate benchmarks like LIBOR and foreign exchange benchmarks.
From the standpoint of market oversight, we believe there should be standards for benchmarks designed to ensure good administration and transparency and to minimize the risk of manipulation. That being said, we believe that direct government involvement in the administration of benchmarks, as has been proposed in the EU, would have adverse market consequences. We think a better approach is that taken by IOSCO in developing general international standards for administration of benchmarks. IOSCO’s Principles for Oil Price Reporting Agencies (PRA Principles) and Principles for Financial Benchmarks provide a framework for price reporting agencies and financial benchmark administrators to address methodology, governance, conflicts of interest, and disclosure. Many price reporting agencies and financial benchmark administrators have already begun voluntarily complying with these standards.
I hope that we can continue to work with our international counterparts to ensure benchmark integrity in a way that recognizes that most benchmarks are not administered by, or regulated by, a government agency.
Overseeing the markets, making sure they are working well, and addressing the needs of participants depends on having resources that are appropriately scaled to the scope of our responsibilities. We have made important progress over the last 8 months, but there is much more we should be doing.
In my view, the CFTC’s current budget has simply not kept up with the growth of the markets and our responsibilities. We cannot be as responsive as we wish to be. Simply stated, without additional resources, our markets cannot be as well supervised; participants and their customers cannot be as well protected; market transparency and efficiency cannot be as fully achieved.
The United States has the best derivatives markets in the world – the most dynamic, innovative, competitive and transparent. They have been an engine of our economic growth and prosperity, in large part because they have attracted participants from all over the work, and they have served the needs of the businesses that depend on them. I look forward to working with you to make sure that they continue to do so in the years ahead.
Thank you for inviting me. I would be happy to take some questions.
Last Updated: March 2, 2015